Schoenmann v. State of California, Franchise Tax Board

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MEMORANDUM DECISION
RE MOTION TO DISMISS 	-1-
UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re
BRYCO FUNDING, INC.,
Debtor.
E. LYNN SCHOENMANN, TRUSTEE,
Plaintiff,
vs.
STATE OF CALIFORNIA, FRANCHISE TAX
BOARD,
Defendant.
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Case No. 08-30173 TEC
Chapter 7
Adv. Proc. No. 09-3087 TC
MEMORANDUM DECISION RE MOTION TO DISMISS
For the reasons stated below, the court denies the Franchise
Tax Board’s motion to dismiss the first amended complaint.
FACTS
On October 16, 2006 and December 29, 2006, Bryco Funding, Inc.
(Bryco) allegedly paid $210,963 (the Transfers) to the Franchise
Tax Board (FTB) to satisfy the personal income tax obligations of
Debtor’s former officers and directors, Bryce Angell and John
Aitken. 	Am. Compl. ¶¶ 6-8, 12.
Signed and Filed: October 09, 2009
________________________________________
THOMAS E. CARLSON
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
October 09, 2009
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Case: 09-03087 Doc# 23 Filed: 10/09/09 Entered: 10/09/09 15:45:06 Page 1 of 8

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MEMORANDUM DECISION
RE MOTION TO DISMISS 	-2-
On February 4, 2008, Bryco filed a chapter 7 bankruptcy
petition. 	E. Lynn Schoenmann was appointed Trustee of Bryco’s
bankruptcy estate.
On January 12, 2009, Trustee filed an action against the FTB
in San Francisco County Superior Court to avoid the Transfers. 	The
parties stipulated to dismissal of that action without prejudice.
On February 2, 2009, the FTB filed a proof of claim against
Bryco, seeking recovery of unsecured and priority taxes totaling
$36,846 for income taxes incurred by Bryco in 2006 and 2007.
On May 15, 2009, Trustee filed an action in this court against
the FTB seeking to recover the Transfers. 	On July 28, 2009,
Trustee filed an amended complaint in that action, seeking to
recover the Transfers from the FTB as fraudulent conveyances
pursuant to Bankruptcy Code sections 548(a)(1)(A) and 548(a)(1)(B).
MOTION TO DISMISS
On August 5, 2009, the FTB filed a motion to dismiss the first
amended complaint. 	The FTB argues that Trustee’s federal
fraudulent-transfer claims are time-barred, because Trustee did not
comply with the California Tort Claims Act. 	California Government
Code section 911.2 establishes a one-year time limitation for suing
the State to recover a fraudulent transfer. 	The FTB argues that
this claim-filing requirement is a substantive element of the
federal claims brought against the State, citing Willis v. Reddin,
418 F.2d 702 (9th Cir. 1969) and United States v. State of
California, 655 F.2d 914 (9th Cir. 1980). 	The FTB also argues that
the federal fraudulent-transfer claims are subject to Government
Code section 911.2, because the federal statute does not expressly
exclude application of California’s Government Code requirements,
Case: 09-03087 Doc# 23 Filed: 10/09/09 Entered: 10/09/09 15:45:06 Page 2 of 8

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MEMORANDUM DECISION
RE MOTION TO DISMISS 	-3-
which are “part of a statutory complex designed to limit
California’s waiver of sovereign immunity.” 	The FTB contends that,
when an essential state interest is at issue, “[t]o displace
traditional state regulation . . . the federal statutory purpose
must be ‘clear and manifest.’” (citing BFP v. Resolution Trust
Corp., 114 S.Ct. 1757, 1765 (1994).
The FTB also seeks to dismiss the complaint on the ground that
Aitken and Angell are necessary and indispensable parties. 	The FTB
argues that if Aitken and Angell are not joined as parties, the FTB
could be compelled to return the Transfers to Trustee, but be
foreclosed from recovering the taxes owed from Angell and Aitken,
because each of them has filed a chapter 7 bankruptcy petition and
has received a discharge.
OPPOSITION TO THE MOTION TO DISMISS
Trustee contends that the exhaustion requirements of the
California Tort Claims Act do not apply, because there is an
independent basis for the bankruptcy court’s jurisdiction. 	Trustee
also argues that, because section 548 defines all the elements of
the federal fraudulent transfer claim, and because section 546
fixes a federal statute of limitations for such claims, application
of the one-year limitation period in the California Government Code
is barred by the Supremacy Clause. 	Trustee notes that compliance
with the claims-filing requirement would be necessary if the
State’s sovereign immunity would otherwise prevent the State from
being sued, but contends that the State has no defense of sovereign
immunity under Cent. Virginia Cmty. Coll. v. Katz, 546 U.S. 356,
370-79 (2006).
Trustee argues finally that Aitken and Angell are not
Case: 09-03087 Doc# 23 Filed: 10/09/09 Entered: 10/09/09 15:45:06 Page 3 of 8

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MEMORANDUM DECISION
RE MOTION TO DISMISS 	-4-
necessary and indispensable parties, because section 550(a)(1)
authorizes Trustee to recover the Transfers from either the initial
transferee or the entity for whose benefit the Transfers were made.
Trustee further argues that failure to join the two officers will
not subject the FTB to a substantial risk of incurring double,
multiple, or otherwise inconsistent obligations, because there is
no risk that the FTB will be obligated to return the Transfers more
than once.
DISCUSSION
1. 	Statute of Limitations
As acknowledged by the FTB, the California Tort Claims Act is
“part of a statutory complex designed to limit California’s waiver
of sovereign immunity.” 	State of California, 655 F.2d at 918. 	The
Supreme Court recently held that sovereign immunity is not an
available defense to fraudulent-transfer actions brought under the
Bankruptcy Code, because the States surrendered their sovereign
immunity with respect to proceedings involving bankruptcy courts’
in rem jurisdiction and remedies ancillary to that in rem
jurisdiction. 	Katz, 546 U.S. at 370-79. 	Because Trustee has sued
the FTB only to avoid and recover fraudulent transfers, the State
may not invoke sovereign immunity to defend against these claims.
The provisions of the California Tort Claims Act can be invoked to
limit enforcement of a federal claim only to the extent that a
waiver of the State’s sovereign immunity is necessary.
The Trustee’s failure to exhaust state-law administrative
remedies does not divest this court of jurisdiction to adjudicate
the fraudulent transfer claims against the FTB, because the
bankruptcy court has an independent basis for jurisdiction over the
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1 The broad statement in Willis that California statutes
conditioning “the right to sue the sovereign upon timely
filing of claims . . . are more than procedural requirements
[, t]hey are elements of the plaintiff’s cause of action”
does not support the FTB’s argument. 	The Ninth Circuit in
Willis expressly stated that California statutes may not
impair federally created rights or impose conditions on them.
Id. at 704-05.
2 Fed. R. Bankr. Proc. 7019; Fed. R. Civ. Proc. 19(a)(1)(A).
MEMORANDUM DECISION
RE MOTION TO DISMISS 	-5-
claims. 	See Sullivan v. Town & Country Home Nursing Svcs., Inc.
(In re Town & Country Home Nursing Svcs., Inc.), 963 F.2d 1146 (9th
Cir. 1992) (failure to exhaust administrative remedy under Medicare
Act and Federal Tort Claims Act did not divest bankruptcy court of
jurisdiction over state-law claims).
Furthermore, the state statute of limitations contained in
Government Code section 911.2 does not apply, because the federal
fraudulent-transfer statute contains its own statute of
limitations. 	11 U.S.C. § 546(a); Reddin, 418 F.2d at 704 (state
statute of limitation applies only in the absence of a federal
statute of limitations); accord State of California, 655 F.2d at
917 (applying state claim-filing statute because no federal
limitations period applied). 1 	The court has not found, nor has the
FTB cited, any case in which a court applied the statute of
limitations established by the California Tort Claims to a federal
claim that contained its own statute of limitations.
2. 	Necessary and Indispensable Parties
I determine that Aitken and Angell are not necessary and
indispensable parties for the following reasons. 	First, the court
may accord complete relief among the existing parties, 2 because
Trustee may recover an avoided transfer either from the initial
transferee of such transfer or from the individual for whose
benefit the transfer was made. 	11 U.S.C. § 550(a)(1). 	The FTB has
Case: 09-03087 Doc# 23 Filed: 10/09/09 Entered: 10/09/09 15:45:06 Page 5 of 8

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28 3 In bringing a complaint to determine dischargeability of
debt, the FTB could avail itself of the nationwide service of
process provided by Fed. R. Bankr. P. 7004, and venue in this
district would appear to be proper under 11 U.S.C. § 1409(a).
MEMORANDUM DECISION
RE MOTION TO DISMISS 	-6-
not cited, nor has the court found, a case limiting or barring a
trustee from recovering a fraudulent transfer from an initial
transferee on the basis that the beneficiary’s liability for the
transfer has been discharged. 	Rather, courts have interpreted
section 550(a)(1) to give a trustee the option to sue either the
initial transferee or the beneficiary, because both are
independently and strictly liable to repay the fraudulent transfer.
Tese-Milner v. Brune (In re Red Dot Scenic, Inc.), 293 B.R. 116,
121 (S.D.N.Y. 2003); Marlow v. United States (In re Julien Co.),
136 B.R. 760, 764-65 (Bankr. W.D. Tenn. 1991); see Shapiro v. Art
Leather, Inc. (In re Connolly North Am., LLC), 340 B.R. 829, 842-43
(Bankr. E.D. Mich. 2006) (that claim against initial transferee was
barred by statute of limitations did not preclude trustee from
recovering transfers from alleged beneficiary).
Second, it is not necessary to join Aitken and Angell to
protect the FTB from multiple or inconsistent obligations. 	It is
true that if the FTB is forced to repay the taxes paid on behalf of
Aitken and Angell, the FTB may not be able to recover those tax
payments from Aitken and Angell themselves. 	This is so, however,
not because Trustee has failed to join Aitken and Angell in the
present action, but because the tax liabilities of Aitken and
Angell may have been discharged in their chapter 7 cases. 	It is
also possible that the tax liabilities of Aitken and Angell are
excepted from discharge under section 523(a), in which case the FTB
can join with the present action a complaint against Aitken and
Angell to determine the dischargeability of their tax liabilities. 3
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MEMORANDUM DECISION
RE MOTION TO DISMISS 	-7-
Trustee cannot assert such a claim, because Trustee does not have
standing to do so. 	To the extent that the tax obligations of
Aitken and Angell were discharged, it is the discharge, rather than
Trustee’s failure to join Aitken and Angell in the present action,
that causes the FTB harm.
**END OF MEMORANDUM DECISION**
Case: 09-03087 Doc# 23 Filed: 10/09/09 Entered: 10/09/09 15:45:06 Page 7 of 8

Court Service List
Dennis D. Davis, Esq.
Katherine D. Ray, Esq.
Goldberg, Stinnett, Davis and Linchey
44 Montgomery Street, Suite 2900
San Francisco, CA 94104
Kristian D. Whitten, Esq.
Office of the Attorney General
455 Golden Gate Avenue, Suite 11000
San Francisco, CA 94102-7005
Case: 09-03087 Doc# 23 Filed: 10/09/09 Entered: 10/09/09 15:45:06 Page 8 of 8